History says don’t count on a big correction anytime soon

It’s been more than two years since the S&P 500 last suffered a 10% correction, a fact that has investors bracing for — or eagerly anticipating — a major pullback that’s often described as long overdue. One long-time Wall Street bull says don’t count on it.

In a Friday note, Deutsche Bank chief strategist Binky Chadha observes that since the end of the last such correction, which he places at June 2012, the S&P 500 gained 55% in the run to its recent peak. While that seems like a “long and big” runup, the performance is actually “fairly typical” outside of long recessions and crises. In fact, he says that on a historical basis, 10%-plus corrections have happened in clusters, with many occurring during the Great Depression in the 1930s, the 1970s bear market and the 2000-03 aftermath of the bursting of the tech bubble.

Chadha says big corrections are unusual mid-cycle, which is where he reckons we are right now. Instead, three-fourths of such corrections happen near recessions (measured as one year on either side) — and almost never occur when the trend in the unemployment rate is down, Chadha writes.

Chadha also downplays the scope of the current rally when stacked up versus other mid-cycle runs. While the average rally between corrections has been 43% over 1 1/2 years, Chadha says the averages are skewed by short rallies interrupted by frequent corrections around crises and recessions. A better comparison are the “long business cycles” of the 1960s, 1980s, 1990s and 2000s, he says, when the stock-market rallies averaged 110% and lasted four years.

Meanwhile, it’s been six months since a 5% pullback in January-February, which is about “average,” Chadha says.

The bottom line:

“We see the mid-cycle rally as having plenty of room to run before we get a 10%-plus correction. Neutral data surprises and positioning suggest that in the event of a smaller-sized 5% pullback in the face of a negative shock, the rebound should be quick.”

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